8709 / What is a casualty loss?

Editor’s Note: Under the 2017 tax reform legislation, individuals are no longer entitled to deduct casualty and theft loss expenses as itemized deductions (when those losses are not related to property used in a trade or business). An exception exists for losses that occur in federally declared disaster areas.¹ However, if a taxpayer has personal casualty gains, the new rules do not apply (even if the loss does not occur in a federal disaster area) so long as the losses do not exceed the gains. This essentially means that casualty losses will continue to offset casualty gains.² This provision applies for tax years beginning after December 31, 2017 and before January 1, 2026. The rules outlined below generally apply for tax years beginning before 2018, and for losses that are sustained in a disaster area.

A casualty loss is a loss that an individual taxpayer suffers as a direct result of an event that meets the following criteria:

(1)  It is identifiable;

(2)  It is damaging to property; and

(3)  It is sudden, unexpected, and unusual in nature.³

IRC Section 165 specifically permits a casualty loss deduction for fire, storm, shipwreck or “other casualty.”⁴ The term “other casualty” has been interpreted to include damage sustained as a result of, among other events, floods⁵ and sudden freezing.⁶ Other deductible casualty losses that are specifically allowed by the IRS include damage caused by fire, earthquake, government ordered demolition or relocation of a home rendered unsafe due to a disaster, mine cave-ins, shipwrecks, sonic booms, storms, terrorist attacks, vandalism and volcanic eruptions.⁷

The Tax Court allowed a taxpayer’s casualty loss deduction for damage caused by blasting operations when the damage caused by the particular blast was unusual and heavier than the blasting that had occurred on a day-to-day basis in the area.⁸ The Tax Court has also permitted a casualty loss deduction for damage sustained due to vandalism, because the vandalism in question was caused by persons outside of the taxpayers’ control, was sudden in nature and destructive in effect.⁹

Damage to property created by termite infestation was not considered to be a casualty loss, because the damage was created by a progressive deterioration of property resulting from a steady cause operating over time—essentially, the casualty loss deduction was denied because the event that caused the destruction was not “sudden” in nature.¹⁰

A taxpayer was not entitled to claim a casualty deduction for losses sustained because of the worthlessness of currency held by the taxpayer. The Tax Court found that “other casualty” must be interpreted to mean an event similar to “fire, storm or shipwreck” and that a decrease in currency value was not a similar event. Further, the Court noted that the taxpayers still held the currency at issue—and thus, it was not technically damaged.¹¹

Further, costs incurred by a taxpayer to prevent a potential casualty loss are not deductible under IRC Section 165 as casualty losses. According to the courts, such preventative steps are not sudden and unexpected in nature, and thus do not qualify as events giving rise to casualty loss treatment.¹²

Special rules apply if a taxpayer suffers a casualty loss within a federally declared disaster area (see Q 8719.).

Generally, casualty losses are deductible during the taxable year that the loss occurred (see Q 8712).¹³